Appraisal Articles 2019 Free Appraisal Articles for Appraisers and the Public
With regard to residential properties, a month-to-month tenancy usually has little impact on market value since the tenant does not control the property for long and residential properties are usually not valued by buyers and sellers based on the income that it produces. If the owner is having problems terminating the tenancy (a hold-over tenant) that is entirely different, but in most circumstances a short-term tenancy is not a problem.
A month-to-month tenancy on a commercial property usually does not increase its value. The terms of a lease on a commercial building, if one exists, is thus very important and a month-to-month tenancy is not the kind of tenancy that most commercial buyers want to see. Thus, the market value of a commercial building is usually positively or negatively affected by the terms of its lease or leases. Yes, there are times when a month-to-month tenancy may be exactly what a buyer wants to see if they plan to terminate the tenancy and use the space themselves. So, there are times when no lease on a single-tenant building can be a positive factor, but vacancies or no long-term leases on a multiple-tenant commercial build is generally a negative factor.
Commercial rentals with short terms, like a year or less, usually do not positively impact value because a month-to-month tenancy or short-term lease do not guarantee a long-term income that can be relied upon. In other words, a number of risks are associated with not having a guaranteed, continued cash flow. In appraisal terms the durability of the income stream is not well established when no long-term rental agreement or lease is in place.
When an established income is not in place for a commercial building, there is no established actual income, appraisers have to analyze the property and establish its market rental rate and from there they then use that established market rate as a basis for valuation. Even when a tenant has been renting a building for 20 years, if there is no rental agreement (lease) in place it is assumed by the appraiser that the rental relationship will not continue. You can go to the bank with a 5-year lease and borrow against that income, but without a lease it's like there is no security to borrow against.
Some long-term leases, like those on fast food restaurants, are seen by many as being like gold. When leases are height-traffic, high-visibility properties a premium lease rates paid and leases have upward adjustments, that often adjust to the consumer price index (CPI), and they often have twenty-year renewable lease terms and given their locations almost no one questions the fact that the tenant will continue to renew the lease until the building is worn out or the traffic pattern changes. Investors pay premiums for leases that steadily increase and are made to credit tenants who can pay on them like clock-work.
At the opposite end of the spectrum are the properties with no lease or a tenant or tenants with month-to-month terms. No one knows if the tenant will still be paying rent for long, they have no commitment to do so, and even if they have been paying rent on time for the last 10 years there simply is no guarantee that they will continue. The risk associated with a short-term lease or no lease at all is great, and when you are buying a commercial building as an investment you have to wonder about whether you are going to receive a reasonable return.
Appraisers analyze lease term in the income approach segment of their appraisal reports. Income if it exists is always considered, and buildings with long-term lease rates that are and remain well below the market rental rate generally have a lower value than those that lease at market rental rates.
Appraisers understand the difference between full service gross (FSG), modified gross (MG) and triple-net (NNN) rental rates and they also understand that rental rates are affected by the size of a space and build-out quality. A rental study is often included in the income approach so appraisers know what the appropriate (market) rental rate is for an appraised property.
For more appraisal information contact Glenn J. Rigdon MA, MRICS, ASA is a Las Vegas / Henderson Nevada based appraiser who can be contacted via email or via his business website known as Appraiser Las Vegas (http://www.appraiserlasvegas.com), or you can also click on “Contact Us” on the home page of this website or visit my public profile at LinkedIn at http://www.linkedin.com/pub/glenn-rigdon-ma-mrics-asa/1a/30b/879/
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